Saturday, 4 January 2014

Investing in 2014

The end of the year is the time to reflect on the past and the beginning of the year is time to reflect on the future.

SO how did your portfolio do last year?

The Dow Jones Industrial Average for US stocks hit 16,576 with a 26%
gain for the year, the best year since 1996. By comparison, the Hang
Seng Index performed 3%; Tokyo Nikkei did best at 57% and Bursa Malaysia
ended 10.5% higher, just a tad off its record high.

On the other hand, the fastest growing economy in the world had the
worst stock performance – the Shanghai A share index closed the year at
-8%. Gold prices fell 27% to US$1,196 per oz, while property prices
seemed to have done well in the United States and China. Bond prices are
now extremely shaky, with the JPM Global Aggregate Bond Index falling by 2% during the year.

What is going on?

The answer has to be quantitative easing (QE) by the advanced country
central banks. The world is still flush with liquidity and since
investors are unclear on what direction to invest in, they have reversed
investments in commodities (such as gold), avoided bonds because of
prospective rises in interest rates and essentially piled into stocks.

Individual investors like you and I tend to forget that the market is
really driven today by large institutional investors, including fast
traders with computer-driven algorithms that have better information
than the retail investor and can trade in and out faster and cheaper. It
is not surprising that retail investors who have traditionally driven
Asian markets have been moving more to the sidelines.

Even institutional investors are not equal. Long-term fund managers
like pension funds and insurance companies are, by and large, highly
regulated, with restrictions on what they can or cannot buy. So it is
not surprising that the biggest money managers are today even larger
than banks. BlackRock, the largest independent fund manager alone looks after nearly US$4 trillion, larger than most banks in emerging markets.

There are, of course, two types of asset management – active (where
the managers actively invest according to their judgement on your
behalf) and passive, where they simply follow the market indices or buy
exchange traded funds (ETFs) that track market indices. According to the
Towers-Perrin study of top 500 global asset managers, during the last
decade, passive managers did better than the group as a whole.

So should we trust the market experts? I have been reading for years Byron Wien’s annual Predictions for Ten Surprises for the Year. Byron used to be a top investment pundit for Morgan Stanley but he is now working for Blackstone.
His prediction of surprises is defined as events where average investor
would assign one-third change of happening, but which he believed would
have a better than 50% change of happening. He got roughly seven out of
ten wrong in 2013, the more relevant mis-calls being the price of gold,
a possible drop in S&P 500, the price of oil and the A share index.

Bill Gross,
one of the top bond fund managers, pointed out that retail investors
tend to be conservative, focusing largely on safe portfolios, such as
investment grade and high yield bonds and stocks. But institutional
investors have gravitated instead into alternative assets, hedge funds
and more unconventional assets. Unfortunately, all these assets are
“based on artificially low interest rates”. So if low interest rate
policies are reversed, investors have to be prepared.

He rightly pointed out that the advanced country central banks are
“basically telling investors that they have no alternative than to
invest in riskier assets or to lever high-quality assets.” But if they
withdraw QE or “taper”, then higher interest rates will cause a reversal
of investment prices and also cause de-leveraging.

In other words, in order to bail out the world and keep the advanced
economies afloat, their central banks are asking global investors to
bear quite a lot of the risks of the downside. The smart money might be
able to get out fast enough, but most retail investors do not have the
skills to time their investments right.

So what should the retail investor do?

Peter Churchouse, who writes one of the best reports in Asia called Asia Hard Assets Report,
quoted his son’s advice as “Buy good companies with strong earnings,
strong growth and rock solid management. The world will go on.”

Quite right.

But how do we know which companies have rock solid management? My
answer is: watch not what the annual report say (by all means read
them), but look at what the management does. I have always tended to shy
away from companies with high-profile CEOs who tend to win “Manager of
the Year” awards.

There is, of course, no substitute for solid own research and look
for yourself how the company or the economy that it operates in is
doing.

The consumer or tourist is still the best investor because seeing for
yourself gives you a feel of what is quite right or wrong with the
country and just visiting the retail outlet, getting a sense of the
service quality and the employee attitude would give you first hand what
is right or wrong with the company you are investing in.

My favourite economy in Asia right now has to be Indonesia. I spent
nearly 10 days over Christmas going through the markets of the most
densely populated cities in Java and my conclusion was that Indonesia is
on the move – literally. The population is young, mobile and connected.
Every other shop seems to be selling mobile phones, cars or motorbikes.
The quality of the retail shops, design and service has been improving
over the years. And despite the coming elections, there is hope for
change.

My bet, therefore, for 2014 is that if we stick to the better-run
companies in the stronger economies, we should be better prepared for
any tapering of QE to come.